What Leverage is ?
No doubt you’ve already heard about leverage. To play on the Forex, it is necessary to play with a leverage to ensure that your transactions are significant and you earn money. This levererage is offers by your broker through lots. So you can play on the Forex with amount of 100.000E with only 1.000E on your account. This is known as leverage. You can use any leverage available from your broker. It’s up to you to choose the leverage you want depending on your risk aversion. More important will be your leverage, the higher your risk will be. Indeed, each variation in pips in the wrong side will cause you a loss more important according to your leverage.
In contrast, the potential profit is enormous but be careful, I strongly advise you not to play with too much leverage. Many people have been ruined because of that! However, be aware that trading with 10.000EUR on the EUR / USD is not a big risk because a change of one pip makes your balance move of one dollar. (For 100,000 deal on EUR / USD 1 pip = $ 10)
From your broker
Each broker has its characteristics as you can see in our brokers section. When you will open a real account in one of them, they will require a minimum deposit. This amount is called initial margin. We will return later in more detail on this concept. Your broker you also specify the amount requested to deal with different types of lots it offers you. Higher is the lot, higher is the leverage and the risk will be more important!
For example, it will tell you that you can trade with lots of 10000E if you have 100E in your account. If you have 400E, you can then trade with 40000E on the Forex. There is no obligation and it is up to you to choose your leverage at each trade. But again, it is advisable to not trade with the maximum leverage available through your broker.
As I said, when you open an account with a broker, there is an initial margin deposit, which is the minimum amount you need to have in your account to trade on the Forex. This margin can range from 100E to 100.000E for some brokers.
Each time you run a new trade, your broker will ask you to have a certain percentage of the traded lot in your account. If we take the example above (100E necessary to handle a lot of 10.000E), the percentage required is 1% (100/10000*100). This is the initial margin required for each trade. So if you trade with a lot of 100.000E, your broker will ask you to have 1.000E, or 1% of the traded amount. From your broker, the percentage requirement will be presented in the following way: 100:1 or 1:100 with mention max leverage.
In your life of trader, you will hear one day or another “margin call”. The margin call occurs when the margin on your account is no longer sufficient to cover the amount of your position. The minimum required by your broker is not reached and you need to restock your account. This case arises when one of your open positions did not go in your side. You’re losing on a trade and your broker automatically cut your position.
Margin calls allows to never entering into negative on your account; you will never have to hand money to your broker with the automatic cut. To avoid automatic cuts of your positions, brokers tend to do a margin call before, to tell you that if this level of price is reached, your position will be cut. If you refund your account, your position will be extended. However, if you answer negatively to the margin call, your broker will automatically cu your position if the margin is no longer sufficient. It is very important to understand how margin calls function before getting on the Forex. Depending on your broker, read the section on the margin call.
We advise you to start trading in demo mode to avoid any unpleasant surprises! Indeed, your positions can sometimes be cut by your broker before the receipt of the margin call if your balance is too low. The most effective way to avoid margin calls is to trade on the Forex with stop loss. So you know in advance the maximum amount of your loss.
You have 500 USD on your account. The margin cut occurs if you reach 900% of margin used. In other words, if the leverage of your position reaches 900% of your capital, the position is cut.
Believing in a fall of the dollar, you decide to buy euro. You take a position of 10 000€ on EUR / USD. At the opening of the position, the leverage used is 20 (10,000/500 : position amount /capital). If the position goes on the right side, the leverage used decreases as capital increases. However, if the position goes on the wrong side, then we can know at how many pips the position will be cut.
Votre position sera coupée automatiquement si vous atteignez 900% de marge utilisée, donc que le montant de votre position est 900 fois supérieure au solde de votre balance. On commence par chercher à quel montant du capital restant, on sera coupé. Donc quand est ce que 10’000/Capital fait 900 soit 11,11€ (10’000/900).
Your position is automatically cut if you reach 900% of margin used, so if the amount of your position is 900 times higher than your balance. We start by looking at what amount of the remaining capital, we will be cut. So when 10,000 / Capital gives 900 so € 11.11 (10,000 / 900).
Then, we make the following calculation: 500 € – 11.11 € = € 488.89 € -> That’s the max amount that you can lose on a trade of € 10,000.
On a position of 10,000 € on EUR / USD, one pip worths $ 1.
You just have to make this calculation (488.89/value of one pips in $) to see how many pips the you can lose before being cut.
The leverage in details
The leverage used is based on the amount of the traded position and on the balance of your account.
As we already said, if you have a trading account with € 1,000 on your balance and you trade with a position of 10,000 on the EUR / USD, you’ll use by position a leverage of 1:10 (10,000 / 1,000). So a one pip variation (0.0001 of the quotes) will worth 1 USD.
Now you decide to trade the GBP / USD, with a position of 10,000. What leverage do you use then? This position GBP / USD implies that you have bought 10,000 GBP. To know the leverage used in this position, simply convert the 10,000 GBP in the base currency of your trading account, so in euros for this example.
If the price of the EUR / GBP quotes 0.8750 at the opening of the position, then the leverage used by your position on GBP / USD will be of ((10,000 / 0.8750) / 1000) or 11’428 €, so a leverage of 1:11,43. 1 pip will still worth 1 USD here because the counterparty currency of the pair is the USD.
NB: the leverage used by this position will chang over the length of the trade given the fact that the EUR / GBP will continue to evolve on its side. But do not worry, this will only affect a little your trade. Example: if the EUR / GBP going from 0.8750 to 0.8650, and you’re still in position of 10,000 on GBP / USD, the leverage which was at the opening of the trade at 1:11, 43 will then up to 1:11,56 ((10,000 / 0.8650) / 1,000).
To sum up:
Leverage used = (Amount of position converted into base currency of your trading account) / amount of the balance of your trading account)